The 2008 Financial Crisis

The 2008 financial crisis, also known as the Global Financial Crisis, was a severe
contraction of liquidity in global financial markets. It originated in the United
States as a result of the collapse of the U.S. housing market. The crisis threatened
to destroy the international financial system and resulted in the Great Recession,
the worst economic downturn since the Great Depression. The crisis was caused
by a combination of factors, including the deregulation of banks, the practice of
securitization, the Federal Reserve's poor timing, lax lending standards, credit
default swaps, overvaluation of mortgage-backed securities, and excessive
leverage.

by Zooheb Khan
Impact of Deregulation

Repeal of the Glass-Steagall Act Complex Financial Instruments

The repeal of the Glass-Steagall Act in 1999 allowed Deregulation also allowed banks to create and sell
commercial banks to engage in investment banking complex financial instruments, such as mortgage-
activities, leading to increased risk-taking and backed securities, which were difficult to value and
speculation. understand.
Securitization and Subprime Mortgages

Lack of Transparency Risky Loans

The practice of bundling subprime This practice also encouraged lenders to
mortgages into securities and selling them make risky loans to people who could not
to investors led to a lack of transparency afford them, as they could simply sell the
and accountability in the financial system. loans to investors.
The Federal Reserve's Role
1 Federal Funds Rate Reduction
The Federal Reserve reduced the federal funds rate 11 times between May 2000 and
December 2001, enabling banks to extend consumer credit at a lower prime rate,
which led to a housing bubble.

2 Encouragement of Risky Loans

The reduced federal funds rate encouraged banks to lend even to "subprime," or
high-risk, customers, leading to a surge in subprime lending.

3 Housing Bubble
People took out mortgages they could not afford, and housing prices soared due to
the poor timing of the Federal Reserve.
Lax Lending Standards
1 Relaxed Lending Standards
Banks and other financial institutions
relaxed their lending standards,
allowing people with poor credit
histories to obtain mortgages they could
not afford.
2 Surge in Subprime Lending
This led to a surge in subprime lending
and a proliferation of adjustable-rate
mortgages, which had low initial
interest rates that later reset to much
higher rates.
Credit Default Swaps and Mortgage-backed
Securities
Insuring Against Default Speculation and Demand Risky Loan
Encouragement
Credit default swaps were used They also allowed investors to
to insure against the risk of speculate on the housing market, This surge encouraged lenders to
default on mortgage-backed leading to a surge in demand for make more risky loans,
securities. mortgage-backed securities. contributing to the crisis.
Overvaluation and Excessive Leverage

Overvaluation
The value of mortgage-backed securities was based on the assumption that housing
prices would continue to rise indefinitely, which proved to be false.

Excessive Leverage
Many financial institutions borrowed heavily to invest in mortgage-backed securities,
which magnified their losses when the housing market collapsed.
Financial Institutions and the Crisis
1 Failure of Major Institutions
The crisis led to the failure of several major investment and commercial banks,
mortgage lenders, insurance companies, and savings and loan associations.

2 Impact of Leverage
Excessive leverage by financial institutions magnified their losses, contributing to
the severity of the crisis.

3 Economic Downturn
The crisis precipitated the Great Recession, the worst economic downturn since the
Great Depression.